For many, loans for college pay off in trouble

Gail MarksJarvisCHICAGO TRIBUNE

It's a decision filled with daydreams and nightmares.

As students ponder what to say in response to the college acceptance letter they've received, their imagination might flit from parties and a glorious career to a noose of suffocating college loan debt.

And the natural question is: Will the good times and subsequent opportunities be worth the debt overhang?

"Too many students don't think about it until they are about to graduate from college," says Mark Oleson, director of the Office for Financial Success at the University of Missouri-Columbia. "But by that time they might have dug themselves into a hole they can't afford."

Oleson, who counsels students on finances, has seen plenty of those holes--students with $80,000 in debt and plans to go into professions like child development or teaching English, he said. "You can't pay $1,000 a month on a $25,000 salary," he said.

About two-thirds of students borrow money to pay for college, and the average graduate leaves a four-year program with about $19,000 in student loans and $3,000 in credit card debt.

According to the College Board, borrowing to pay for college generally makes sense because education builds earning potential. The typical college graduate earns about 73 percent more than the typical high school graduate, and the higher pay covers the cost of four years of tuition and fees by the time the graduate is 33. The higher cost of private colleges adds an extra burden. But by age 40 students typically have covered those costs too.

But Oleson tells students not to base their decisions on the typical student. Debt levels might be too high if students are not likely to complete college or if they plan a career in a low-paying profession.

In a recent poll of 1,508 college graduates between 21 and 35, Mathew Greenwald & Associates found that 44 percent delayed buying a house because of the burden of student loans. And 28 percent postponed having children. About 27 percent skipped medical or dental procedures, and 32 percent said college loans and credit card debt for college forced them to move back into a parent's home or live there longer than they expected.

A 2003 national student loan survey by Nellie Mae, a subsidiary of SLM Corp., found that 54 percent of graduates said they wished they had borrowed less for college. If they had known in high school what they experienced after college graduation they would not have taken on as much student debt as they did. That contrasted greatly with 1991, when Nellie Mae found only 31 percent of graduates regretted their debt levels.

With the cost of college climbing at a faster rate than inflation, College Board researcher Sandy Baum and Saul Schwartz, a professor at Carleton University in Canada, recently explored the question, "How much debt is too much?"

While people who borrow often believe they will not be overextended if a lender seems confident they can handle a loan, Baum and Schwartz warn against that assumption.

"Lenders determine the maximum amount that they are willing to offer loan applicants on the basis of extensive analysis of loan histories," according to the researchers. But the lenders focus on how likely a default will be--in other words, the odds that the borrower will be completely unable to repay a loan. They do not look at what paying will mean to the individual's lifestyle.

"Our sense of what the word 'manageable' means is quite different from what lenders have in mind," Baum said.

For many years analysts of student debt relied on the idea that graduates should not devote more than 8 percent of their gross income to repaying student loans. Baum and Schwartz trace the idea back to the mortgage industry, which historically has limited housing payments to 25 to 29 percent of monthly income and then assumed that other debt would not exceed 8 percent of income.

There are problems with such a formula, because student loans are not the only extra debts people have besides a home. There are car loans, credit cards and other personal loans. In the Nellie Mae study a third of the respondents paid $1,000 or more a month in those debts, and only 15 percent owed less than $250 a month on debts other than student loans and housing.

Because of housing, transportation and other necessities, Baum and Schwartz note that lower-income people have to devote more of their income to basics and will not be able to afford as much college debt as higher-income people. They said that higher-income people may be able to afford college loan payments that far exceed 8 percent of their income--perhaps as much as 18 for a person making $150,000.

They also found that family backgrounds matter. When they analyzed the Nellie Mae study the researchers discovered that people from low-income families felt more burdened by loans than other graduates--even when the loan size and existing income levels were the same.

Borrowers with incomes below 150 percent of the poverty level ($14,700 for a single person and $19,800 for a household of two people in 2006) should not be expected to make loan payments, the researchers said.

The average liberal-arts graduate in 2006 was earning about $30,000 and could afford debt payments no larger than 10 percent of their income, they said. That's $22,160 in student loans charging 6.8 percent interest. To take on about $36,600 in student loans, the researchers said, the person would need to make about $40,000 (the loan payments would be 14 percent of their income). For $87,330 in student loans a $75,000 income would be necessary to cover payments (16 percent of income).

Before deciding on a college, and loans, Oleson suggests thinking about the student's likely career choice and pay.

A calculator at www.finaid.com will help. Under Calculators, choose Student Loan Advisor-Undergraduate Students. It gives you a glimpse of the likely pay for your career choice and shows you whether your loan payments are likely to be manageable, given your career plans.

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Burden of student loans

A recent poll of 1,508 college graduates between 21 and 35 found that ...

44% delayed buying a house

28% postponed having children

27% skipped medical or dental procedures

Source: Mathew Greenwald & Associates

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Absorbing student loan debt As your post-college income rises, experts say, so does your ability to pay off student loan debt. But they say your payments should never reach 20 percent of your income. Here is a guide: %% If you make this ... then you can Annual Portion

much per year ... handle this much* payment of income

$10,000 $0 - -

$20,000 $7,680 $1,060 5%

$30,000 $22,160 $3,060 10%

$40,000 $36,640 $5,060 13%

$50,000 $51,120 $7,060 14%

$75,000 $87,330 $12,060 16%

$100,000 $123,540 $17,060 17%

$150,000 $195,950 $27,060 18%

*Total student loan debt at 6.8 percent interest rate

Source: The College Board

Chicago Tribune

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Gail MarksJarvis is a Your Money columnist and author of "Saving for Retirement Without Living Like a Pauper or Winning the Lottery." Contact her at gmarksjarvis@tribune.com.